Cogent Communications Holdings Inc (CCOI) 2012 Q1 法說會逐字稿

Good day, and welcome to the Cogent Communications Group, Incorporated, quarter one 2012 earnings conference call and webcast. Today's conference is being recorded. A replay will be available on the company's website at www.cogentco.com.

At this time, I would like to turn the conference over to your host, Chief Executive Officer, Dave Schaeffer. You may begin.

Thank you, and good morning. Welcome to our first quarter 2012 earnings conference call. I'm Dave Schaeffer, Cogent's Chief Executive Officer. With me on this morning's call is Tad Weed, our Chief Financial Officer.

Our results for the quarter came in as we anticipated. We are optimistic about our outlook for the remainder of 2012. But as we discussed on our year-end 2011 earnings call, the loss of our largest single customer, Megaupload that occurred in January 2012, negatively impacted our revenue growth, traffic growth, and margin expansion.

The loss of Mega, which represented approximately 5.5% of our 2011 revenues and Q4 2011 revenues, materially impacted our revenues in the first quarter. Our revenues declined from the fourth quarter by 2.8%. On a constant currency basis, however, this decline was more moderate at 2.4%.

Our revenue increased from the first quarter of 2011, by 4.7%, and on a constant currency basis, that increase would have been 5.6%.

As mentioned in our press release, at our April 19th, board meeting immediately following our shareholder meeting, our Board of Directors approved a recurring dividend of $0.10 per share for common stock. The record date for this first dividend payment will be approximately September 15th. The Board action to set the exact record date will be taken at a subsequent 2012 Board meeting.

During the quarter, traffic declined on our network by approximately 16% from the fourth quarter, but increased 9% from the first quarter of 2011.

We continue to invest in the growth of our network. Since the end of the fourth quarter, we expanded our footprint by adding an additional 25 buildings and an additional 2,900 metro fiber miles to our network. We remain extremely encouraged about the level of our order backlogs, orders signed but not yet installed.

Throughout this discussion, we will highlight several operational statistics that we believe demonstrate our increasing market share, expanding scale and size of our network, and, most importantly, the leverage within our business model. We continue to believe that there is a significant barrier [to] entry for anyone trying to replicate the assets that we have assembled here at Cogent. We are the low-cost and most efficient operator in our sector, focused on the most revenue rich locations which we then bring On-Net, selling the highest quality Internet service to our customers at the absolute lowest prices in the industry.

I will review in greater detail certain operational highlights and continued expansion plans. Tad will provide some additional details on our financial performance, and then following our prepared remarks, we'll open the floor for questions and answers.

Now I'd like to turn it over to Tad to read our Safe Harbor language.

Thank you, Dave, and good morning, everyone. This first quarter 2012 earnings report and this earnings conference call discuss Cogent's business outlook and contain forward-looking statements within the meaning of Section 27(A) and 21(E) of the Securities Act. Forward-looking statements are based upon our current intent, beliefs, and expectations. These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties and actual results may differ materially. Please refer to our SEC filings for more information on the factors that could cause actual result to differ.

You should also be aware that Cogent's expectations do not reflect the potential impact of mergers, acquisitions, other business combinations or financing transactions that may be completed after today. Cogent undertakes no obligation to release publicly any revision to any forward-looking statement made today or otherwise update or supplement statements made on this call.

Also, during this call, if we use any non-GAAP financial measures, you'll find these reconciled to the GAAP measurement in our earnings release and on our website at cogentco.com.

Now I'll turn the call back over to Dave.

Thanks, Tad. Now for a few highlights from our first-quarter results. Hopefully you've had a chance to review our earnings press release. As within previous quarters, our press release includes a number of historical quarterly metrics. These metrics will be added to our website, and hopefully you find the consistent presentation of these metrics informative and helpful in understanding our financial results and the trending in our operations.

Our first quarter 2012 revenues came in at $76.9 million, a decrease of 2.8% from our fourth quarter revenues, and an increase of 4.7% from our first quarter of 2011 revenues. On a constant currency basis, this revenue decrease sequentially was only 2.4%, and the revenue increase on a year-over-year basis Q1 of 2011 to Q1 2012, was 5.6%.

We evaluate our revenues based on product class. That is On-Net, Off-Net, and non-core, which Tad will cover in greater detail. We also evaluate all of our revenues by customer type. We have two primary types of customers, NetCentric customers and corporate customers. All customers are categorized in two ways, either as corporate or NetCentric and as either On-Net, Off-Net, or non-core. NetCentric customers buy large amounts of bandwidth from us in carrier neutral datacenters. Corporate customers buy bandwidth from us in multitenant office buildings.

Revenues from our corporate customers grew approximately 1% from the fourth quarter of 2011. Revenues from Megaupload, which was 100% On-Net NetCentric customer did not impact our corporate revenue growth and traffic from our corporate customers. These corporate customers now represent 53% of our total number of connections at the end of the quarter and represent approximately 51% of our revenues in Q1 2012.

Our corporate customer connections grew sequentially by approximately 2%. Revenues from our NetCentric customers, including the loss of Mega, decreased approximately 6% from the fourth quarter. The impact to foreign exchange has a greater impact on our NetCentric customers. Our NetCentric customers represent 47% of our customer connections at the end of the quarter and approximately 49% of our revenues in Q1 2012. Our NetCentric customer connections grew in the quarter, despite the loss of Mega, by approximately 3%.

Now for some overall highlights, first we'll talk a little bit about pricing. Our most widely sold corporate product continues to be 100 megabit per second, and our most commonly sold NetCentric product is a 10 gigabit connection. We offer discounts related to contract term to all of our corporate customers. And to our NetCentric customers, we offer discounts based on contract term and volume commitment.

During the quarter, over 1,000 NetCentric customers took advantage of our volume and term discounts and entered into longer contracts with Cogent, increasing their aggregate revenue commitment to us by slightly over $10.6 million.

Customers also continue to express their confidence with Cogent in entering into longer term contracts with us. Our average contract term increased again by another 1% in the quarter. More than 1 out of every 3 Cogent customer contracts entered into in the first quarter was a 2- or 3-year contract. As a reference point, 2 years ago, these multi-year contracts represented less than 1-in-10 of our customer contracts.

Now for our NetCentric customers, pricing per megabit of new contracts continue to decline. However, for the first time in several years, the price per megabit at our installed base actually increased in the quarter. Our average price per megabit at our installed base increased 6.4% in the quarter, from $3.58 in the fourth quarter of 2011, to $3.81 in the first quarter of 2012. The price per megabit for new contracts entered into in the quarter was $2.36 a megabit, down 7.3% from the $2.54 per megabit for new contracts sold in the fourth quarter.

The decline in price per megabit for new contracts is predominantly attributable to certain targeted promotional activities that we have initiated in response to recent industry consolidation.

Now to touch on ARPU. Our On-Net ARPUs for corporate and NetCentric customers combined, declined by 7.8%. Our On-Net ARPUs were $793 in the fourth quarter of 2011, and $731 in the first quarter. Our Off-Net ARPUs, which are predominantly corporate, continue to increase, and increased by 1.7% from the fourth quarter as the size of the average corporate customer connection continues to increase. Our Off-Net ARPUs increased from $1,623 in the fourth quarter to $1,650 in the first quarter.

Now, before Tad provides some additional details on the quarter, I'd like to address our results and expectations against our announced revenue and EBITDA targets.

As a reminder, we updated our expectations for the first quarter of 2012, and full-year 2012, due to the one-time extraordinary event of the loss of our largest customer. Again, we normally do not provide guidance on a quarterly basis, but, as in the past, we have provided general annualized target goals.

Due to the loss of our largest NetCentric customer in January 2012, Megaupload, which represented 5.5% of our revenues and approximately 11% of our NetCentric revenues in 2011, and the high operating leverage associated with our On-Net business, we announced and expected to experience a decline in revenue, EBITDA, EBITDA margin, and traffic on a sequential basis from Q4 2011 to Q1 2012. In fact, these results did occur as expected.

However, the trends from our underlying business remain extremely strong. After we absorb the impact of this one event, we expect that beginning in our second quarter, our top-line sequential revenue growth quarter-over-quarter will resume at similar rates that we have demonstrated in the past. We expect that our revenue growth for full-year 2012, over full-year 2011, may be slightly below our annualized targets of 10% to 20%, due to the impact of Mega.

We expect that the extraordinary increase in EBITDA margin that we should expect to see as we migrate from the first quarter of 2012, to the second quarter of 2012, will allow us to resume our more normalized upward path in EBITDA margin expansion beyond the second quarter, to an annualized rate of about 200 basis points year-over-year.

Unrelated to this event, and on a calendar-year basis, we expect to continue a reduction in our absolute capital expenditures for 2012, as compared to 2011, of approximately 10%.

We continue to anticipate our full-year revenue growth for 2013 over 2012, to be within the 10% to 20% range, and our EBITDA margins for 2013 over 2012, to increase by at least 200 basis points.

Now I'd like Tad to spend a few minutes on some additional details related to our results in the quarter.

Thank you, Dave, and, again, good morning to everyone. I'd also like to thank and congratulate our entire team on their hard work and efforts during the quarter. I'll begin by providing additional details on our revenue by product class.

Our On-Net revenue was $56.8 million for the first quarter, which was a decrease of 4.7% from the fourth quarter. While we continued to add On-Net customers to our network, the impact of the loss of Megaupload negatively impacted our On-Net revenue results.

Similar to prior quarters, approximately 85% of our new sales in the quarter were for our On-Net services. Our On-Net customer connections increased by 2.9% for the quarter, and we ended the quarter with about 26,300 On-Net customer connections on our network in our 1,769 On-Net buildings.

Our revenue from our Off-Net business was $19.5 million for the quarter, which was an increase of 3%, as we continued to add Off-Net customers to our network and also from the impact of the continued increase in our Off-Net ARPU. Our Off-Net customer connections increased by 1.2% for the quarter, and we ended the quarter serving about 3,960 Off-Net customer connections in about 3,900 Off-Net buildings.

We continued to experience an increase in Off-Net connection size in ARPU due to the increase in the availability of Off-Net Ethernet services in lieu of traditional TDM services.

Our non-core revenues were about $0.6 million for the first quarter, and represent less than 1% of our revenues and about 550 customer connections.

Related to churn, our On-Net monthly gross churn rate, including the impact of the loss of Megaupload, was 2.7% for the first quarter, that compares to 2.4% for the fourth quarter. This gross churn rate also includes customers who remain with Cogent but enter into amended or move/add/change Cogent contracts. If you exclude the increase in move/add/change contracts, but including the impact of the loss of Megaupload, our On-Net churn rate was 1.6% for the quarter.

Off-Net gross monthly churn rate was 2.8% for the first quarter, the same as the 2.8% for the fourth quarter. Again, if you exclude the increase in move/add/change contracts, our Off-Net churn rate was 1.9% for the quarter.

Our EBITDA margin declined by 590 basis points in the first quarter sequentially, from the impact of the loss of Megaupload and from the expected impact of seasonal increases in our SG&A expenses. Our EBITDA margin was 29.3% for the first quarter, and EBITDA, as adjusted, was $22.6 million for the quarter.

Our gross profit margin decreased by 240 basis points for the quarter, from 57.8% to 55.4%. Our On-Net revenues continue to carry 100% direct incremental gross profit margin and our Off-Net revenues continue to carry a 50% incremental direct gross profit margin.

Occasional lumpiness in our EBITDA and gross margin can and does occur in EBITDA margins. If you examine our quarterly metrics for the last 28 quarters, included in each of our press releases, you'll notice lumpiness in our quarterly margin expansion. This lumpiness can occur due to seasonal factors. Seasonal factors include the resetting of the payroll taxes in the United States, our annual sales meeting costs, and cost-of-living increases, which occur in our first quarter, the timing of our audit and tax services, which are also greater in our first quarter, and then the timing and scope of our expansion activities, which varies from quarter-to-quarter.

Additionally, in the first quarter of 2012, we experienced an increase in bad debt expense, primarily due to the loss of Megaupload, and we experienced the loss of Megaupload on that revenue.

Our long-term trend has demonstrated that our business model generates increasing EBITDA margins. But as Dave mentioned, we expect that our EBITDA margin will significantly expand from the first quarter of 2012 to the second quarter of 2012.

Interest expense results from interest incurred [on] our $175 million of senior notes that we issued last January, 2011, and our $92 million of 1% convert senior notes and interest on our capital lease obligations. Our interest expense was $9 million for the first quarter, compared to $8.8 million for the fourth quarter of 2011.

Basic and diluted income per share was $0.12 of income per share for the fourth quarter, and our basic and diluted loss per share was $0.05 for the first quarter of 2012. Included in the fourth quarter of 2011, was an income tax benefit and other tax adjustments netting to a tax benefit totaling $3.4 million, and that represented $0.08 per share for the fourth quarter of 2011. If you exclude tax benefit from the fourth quarter, our basic and diluted income per share for the fourth quarter would have been $0.04.

Reducing our loss per share for the first quarter of 2012, was an income tax benefit of $700,000. This tax benefit represented about $0.01 per share on the quarter. So if you exclude that tax benefit, our EPS for the first quarter of 2012, would have been a loss of $0.06. So the recurring amounts for the first quarter of 2012 is a loss of $0.06, and the fourth quarter of 2011, would have been about $0.04.

Foreign currency impact, about 27% of our business is located outside of the US. About 20% of our revenues are based in Europe and about 7% of our revenues are related to our Canadian and Mexican operations. Continued volatility in foreign exchange rates can materially impact our comparable quarterly and annual revenues and financial results. The foreign exchange impact on our revenues from the fourth quarter to the first quarter was a decrease of about $0.3 million. Our revenue declined from the fourth quarter by 2.8%, but on a constant currency basis, that was a decline of 2.4%.

The foreign exchange impact on our revenues from the first quarter of 2011 to the first quarter of 2012, was a decrease of about $0.7 million. Our revenue increased from the first quarter of 2011 to the first quarter of 2012, by 4.7%. If you adjust for foreign exchange, that increase was 5.6%.

The average euro to US dollar rate thus far in the second quarter of 2012, is about $1.31, which is essentially the same as the average exchange rate for the first quarter of 2012. So if those rates remain at current levels, there will not be a material impact on sequential quarterly revenues related to foreign exchange.

Customer concentration. Our revenue and customer base of approximately 31,000 customer connections is now not highly concentrated. For 2011, our top 25 customers, which included Megaupload, was about 12.5% of our revenues. After the loss of Megaupload, our next largest customer represented about 1% of our first quarter 2012 revenues, and our top 25 customers for the first quarter of 2012 are about 6.5% of our revenues.

CapEx, on a quarterly basis we can and have historically experienced seasonal variations in CapEx, prepaid capital lease payments, and construction activities. Our quarterly CapEx and prepaid capital lease payments are, in part, dependent upon the number of buildings we connect to the network each quarter and the timing and scope of our network expansion activities.

Our CapEx for the quarter was $12.3 million versus $10.4 million for the fourth quarter of 2011. As Dave mentioned, we added another 25 buildings to our network in the first quarter, and we've added 160 On-Net buildings in the last 12 months. Since the end of the last quarter, we added over 2,900 metro fiber miles to our network.

Our capital lease payments, including prepaid capital and leases was $7.1 million for the first quarter and $2.1 million for the fourth quarter of 2011.

We expect to continue our network expansion in 2012, but at a slightly more moderate pace than we experienced over the last two years.

At the end of the quarter, our cash and cash equivalents were $232.3 million. For the quarter, cash decreased by $5.9 million, as our $12.7 million of operating cash flow was offset by the $12.3 million of CapEx and $7.1 million of IRU capital lease payments, including prepaid capital leases.

Operating cash flow for the first quarter included our semiannual interest payment of $7.3 million on our senior notes made in February, and the impact of the loss of Megaupload. Our operating cash flow will continue to be impacted by the $7.3 million of semiannual interest payments on our senior notes that is paid each February and August through the maturity date in 2018.

We have about $92 million of our original $200 million face value of our convertible notes remaining. These notes mature in June 2027, and may be redeemed by us or [put] by the holders beginning in June of 2014. The notes are reported on our balance sheet at $78 million, which is net of their unamortized discount.

Our capital lease IRU obligations are for long-term dark fiber leases, and typically have initial terms of 15 to 20 years, and also include multiple renewal options. These capital lease IRU obligations totaled $133.1 million at the end of the quarter. Our bad debt expense, including the impact of Megaupload, was 2.8% of our revenues for the first quarter of 2012, above our normal average rate of about 1.5% to 2% of revenues per quarter.

Our day sales outstanding for worldwide accounts receivable was 28 days at the end of the quarter, which was unchanged from the 28 days outstanding at year end. And as in each quarter, I want to personally thank and recognize our worldwide billing and collections team for continuing to do just a great job on customer collections and credit monitoring.

And now I'd like to turn the call back over to Dave.

Good. Yes, and thanks, Tad. We're going to spend a couple minutes on our sales force and productivity. We began the first quarter with 301 quota bearing reps and ended the quarter with 273 quota bearing reps selling our services. We hired 32 reps in the quarter, and 60 sales reps left the company during the quarter. Our monthly rep turnover was 7% in the first quarter.

We began and ended the quarter with the same number of full-time equivalent reps. These are reps that have ramped and are productive, of 269 reps.

Productivity on a full-time equivalent basis for the quarter was 4 units of install business per month per rep. This performance is consistent with our long-term historical average, which is actually 4.07 units per rep per month. As a reminder, our rep productivity numbers are based not on contract signing, but rather are based on completed customer installation.

Our network scale continues to expand. We added 25 buildings to our network in the first quarter of 2012, bringing our total footprint to 1,769 buildings On-Net at the end of the quarter. Our network size also grew as our metro network now consists of 19,800 metro fiber miles and over 56,200 intercity route miles of fiber. The Cogent network is one of the most interconnected networks in the world, today connected to over 3,940 networks. Approximately 45 of these networks are settlement free peers. The remaining approximately 3,900 networks are actually customers of Cogent who pay us for connectivity.

We are currently utilizing about 15% of the lit capacity in our network. We routinely augment parts of our network to maintain low utilization on the network. We have a well-diversified customer base with low revenue concentration. No customer today represents more than 1% of our revenues. We believe our network has substantial available capacity to accommodate future revenue growth.

We continue to evaluate additional routes and have taken advantage of certain opportunities presented to us in volatile markets. We continue to be opportunistic and take advantage of these opportunities when and if needed.

So in summary, we believe that Cogent is the low-cost provider of Internet connectivity and our value proposition is truly unmatched in the industry. Our pricing strategy continues to be aggressive and attract many new customers, resulting in longer contract terms, increased volume commitments, and increased revenue commitments from our customers.

Our business is entirely focused on the Internet, and the Internet increasingly has become a absolute necessity and a utility for our customers. After experiencing a decline this quarter, we expect our annualized revenue growth and EBITDA margin expansions to return to their historical levels.

We are opportunistic about the purchasing of common stock. As of the end of the first quarter of 2012, we had purchased 232,000 shares under our $50 million authorization program at a cost of $12.78 a share, spending about $3 million. We still have $47 million remaining under this buyback authorization that is in place until February 2013. We will be opportunistic about using this in conjunction with our dividend program.

We continue to be very encouraged by the results of our sales initiatives and particularly our targeted promotional activity and our record sales backlog. We are committed to providing annualized top-line revenue growth of 10% to 20%, and expending our EBITDA margins, and, most importantly, generating increasing amounts of free cash flow for our equity holders.

We like and are confident in our network reach, our product set, our addressable market, our operating leverage. In short, we continue to like our business.

In April of 2012, our Board of Directors approved our first recurring quarterly dividend of $0.10 per share per quarter, demonstrating our commitment to shareholders, our optimism regarding the return of capital to our shareholders on a regular basis, and our optimism concerning our growth in free cash flow going forward.

With that, I'd like to turn the floor over for questions.

Yes. Thank you. (Operator Instructions) Dave Coleman with RBC Capital Markets.

Thank you. Just a couple questions, first on the EBITDA guidance, just looking for clarification. I may have misinterpreted the comments. But you said for 2012, that the EBITDA margins would resume a more normal upward path of about 200 basis points year-to-year. How does the Megaupload shutdown factor into that? I'm assuming that margin progression in '12 over '11 would be lower than that, but just want to make sure that I'm understanding that properly.

And then you mentioned a decline in the headcount by, I think 28 sales reps. How does that impact your ability -- well, I guess is that voluntary or involuntary reductions? And how does that impact your ability to hit the 10% to 20% top-line growth in out years?

And then finally, just can you talk about any successes you've had in getting new business from video aggregation sites since the Megaupload shutdown? Thank you.

Sure, Dave. First of all, on EBITDA margin, three points. First one is, we took a significant hit in the first quarter, 590 basis points of sequential decline in EBITDA margin due to the extraordinary bad debt expense and the loss of high incremental margin business. We will not have that bad debt expense recurring, and we continue to sign incrementally profitable high-margin business.

So investors should expect a significant rebound in the sequential Q1 to Q2 EBITDA margin of about 300 basis points on a sequential basis. After that, we will resume a more normal rate of annualized growth of about 200 basis points or 40 or 5 basis points a quarter, of margin expansion. This does result in a relatively flat margin for 2012 over 2011. But what we do expect is to see 2013 over '12, again up another 200 basis points, and then that growth to continue in the out years.

Now with regard to the sales force, as tough as we are in terms of quantifying and holding people accountable to specific metrics, we generally don't terminate people that are underperforming around the holidays. So the first quarter tends to be the worst quarter for turnover. The vast majority of that headcount reduction, those 60 people that left the company, were actually asked to leave. They were involuntary terminations due to these individuals generally not meeting their quota objectives.

We continue to hire people and we expect to see a acceleration in our rate of hiring. It's a little slower in the first quarter because we're distracted with our sales meeting. But we expect to continue to grow our headcount back to the 300 and maybe even above that number over the next quarter or two.

With our ability to hit our long-term revenue growth, we feel quite comfortable that we have the right sales process, the right sales approach, the right products, the right pricing strategy, and the right people to achieve those objectives. We are down slightly today on headcount, but we are also seeing some additional customers and productivity from our existing sales force. And we will also be hiring additional headcount to get us back up to where we need to be to serve our addressable market.

And then finally, on video sites, we generally do not issue press releases on specific customers and names. We did see a significant drop with the loss of Megaupload. We are very careful to make sure that the sites that we're dealing with are ones that are not going to be subject to governmental action. We have seen some uptick from other file sharing sites, but also from more paid type sites. We have seen an uptick, for example, in traffic from Netflix and others as we continue to see other video distribution models kind of replace the model that Mega had.

So we actually saw the largest rate of sequential traffic growth on a month-over-month basis in three years when we went from February to March of this year, and we're expecting to see continued growth. As we monitor traffic actually on a daily basis, we're seeing continued upticks in April at accelerated rates. We report on a quarterly, not on a daily basis. But we feel very comfortable that we're continuing to gain both traffic and market share in the video market space.

That's great. Thanks a lot.

Great.

Barry McCarver with Stephens, Incorporated.

Thanks for taking my question. So first off, can you just give us the exact dollar amount of the bad debt expense in a quarter that was related to Megaupload? I'm assuming that's the piece that's just totally one-time in nature?

That's right. Our total bad debt increase in the quarter was between $1.5 million to $2 million. We're a little reluctant to give the exact-to-the-penny number on Mega because it's still under litigation and we have a claim against the moneys that the government has seized. But that was the extraordinary bad debt expense.

And then you need to think about it as our normal bad debt expense run rate is around 1.5% to 2% as opposed to the 2.8% that we had in the quarter. So it's really that differential that is primarily ascribable to Mega.

Okay. So you took the maximum amount and you're hoping to get some of that back then?

Well, we're --

It's fully reserve.

Yes, it's fully reserve. We've taken the hit. But, yes, we are putting a claim in to the moneys. When the government shut down Mega, they actually seized Mega's bank accounts, and there was approximately $42.5 million in those accounts. We are one of their primary creditors and are placing a claim for that money. But we've reserved it. Right now we're not anticipating getting it back, but we're going to pursue all due process as vigorously as possible to get that money.

Thanks. Then as it relates to the sales force, as we see this decline in the number of new buildings you bring on, you've talked quite a bit in the past about refocusing the sales force to go back and add additional customers to your current stash of On-Net buildings. Can you talk about that opportunity and kind of where you are in the process of refocusing the sales force?

Sure. So we increased our penetration in our corporate buildings, our On-Net corporate buildings, to 10.3 customers per building, up from 10.1 the previous -- or 10.2 the previous quarter. There are 51 opportunities on average in those buildings. We anticipate continuing to increase our penetration in the corporate footprint at about 1.8 additional customers per existing building per year and approximately doubling our penetration.

We need to be in front of customers when their current contracts run out. And our sales force continues to grow to make sure that we have enough resources on the corporate side to get in front of all those potential customers.

In the Off-Net corporate business, which is about [40%] of corporate revenues, they're typically tied to On-Net relationships. [There], our building penetration is somewhat irrelevant. As Tad mentioned, we have about 3,960 connections in 3,900 unique buildings. There's no real incentive for us to add more in a building because we buy a tail circuit to serve each customer independently.

Finally, in the datacenters, we continue to be very aggressive. Today we have about 10.8% penetration in those datacenters. We actually have 21.5 customers per carrier neutral datacenter that we're in. And the sales force continues to be focused on adding additional customers and, most importantly, additional revenues in those facilities.

So just thinking out a little longer term, I guess beyond this year, that 1.8 per On-Net building per year, is that the metric that we should expect to move up a little bit going forward?

Well, I think two things happen. The reported number, if you go back and look at the past 28 quarters of data, we actually have experienced about 1.1 additional customers per building per year, because what's happening is the existing base is growing at 1.8, and the base is getting bigger with buildings that have zero customers. So that reported number has been about 1.1 additional.

As the rate of new buildings declines, and remember it hasn't declined significantly yet, we added 160 buildings over the past 12 months, 25 in the most recent quarter, you should expect to see growth rates comparable to the past. In the very long term, if you look three or four years out, approximately 92% of our growth each of the past three years has come out of the footprint that was On-Net two years prior and only about 8% of our growth has come out of new buildings added in the short term. Now, why we add buildings [is] to grow our addressable market.

So I don't think you should expect to see any significant deceleration in our growth rate for at least 5, 6 years, even if we slowed the pace of adding new buildings to the network, as we will continue that 1.8 additional customers per building, and the 1.1 will converge to the 1.8, as we are not adding as many buildings with no customers.

Fair enough. Then just lastly, can -- we ask every quarter. But can you talk just a little bit about competition and maybe split that up both domestically, internationally, and any kind of change in any pricing from some of the bigger competitors trying to block your market share gains?

So let's take both our corporate business and our NetCentric business and answer those separately, and to remind you, our corporate business is solely in North America.

There we're almost exclusively competing with the incumbent or a reseller of the incumbent's facility. We've seen a very stable pricing environment where our competitors are trying to sell a complete bundle of services as opposed to kind of naked Internet service. And we remain, by far and away, the most compelling value proposition in our On-Net footprint and have seen no change in pricing dynamics in the past several years from our competitors, which are predominantly the incumbent Telco operators.

Now, in our NetCentric business, which is actually almost equally split between North America and Europe, we continue to see downward pricing pressure led actually by us. The competitive landscape continues to shrink with the combination Level 3 and Global Crossing, they are our primary competitor ubiquitously. Regionally, we see folks like NTT, Italia, Telecom Italia, PCCW, as kind of regional competitors.

But I think it's pretty illustrative that our price per megabit in our installed base actually increased for the first time in at least a half a dozen years. And I think as we resume accelerated traffic growth after we get past the impact of Mega, we should expect to see kind of the normal dynamic in place. But even if you took a snapshot of the last year, so if you took Q1 2012 over Q1 2011, the average price per megabit to our NetCentric customers declined 7% from $4.10 to $3.81. During that same period, traffic was up 9%. NetCentric revenues, and this includes the impact of Mega, the loss of our 11% customer, it was up 1.3%. And if you constant currency that, it was up 2.2%.

So even in a competitive market, and we are committed to being the absolute price leader in the market, we're able to grow our revenue right in the middle of our guidance range.

That's great color. Thanks, Dave.

Frank Louthan with Raymond James.

Great. Thank you. Can you give us an idea of some of the seasonal items that usually sort of impact the margins in Q1? Was any of that pushed to Q2? And then can you give us an update on how much longer you expect sort of the M&A-related promotional activity to continue? You've been fairly successful with that. It's gone on for a couple more questions longer than we thought. What's sort of the longevity of that promotion? Thanks.

Sure. This is Tad. I'll take the seasonal question. So I think we've said this pretty much on every call, in particular kind of the fourth quarter and first quarter calls, because the seasonal changes we see in SG&A tend to happen from the fourth quarter [to] the first quarter. So the buckets of those changes include increases in salaries and benefits for employees. We have -- our compensation changes occur in January - 1% to 2% has been the historical increase there.

Secondly, you've got the resetting of payroll taxes, in particular in the United States, as people reset on their FICA and Medicare balances. We have our sales meeting, which has historically been in January. And then lastly, audit activities associated with the year-end audit and the filing of the 10K and the proxy occur in the first quarter.

If you aggregate those amounts, it's about $1 million from the fourth quarter to the first quarter of this year. And the other part of the increase in SG&A quarter-over-quarter attributed to the Megaupload bad debt expense. I think kind of the way to think about it would be, what are we expecting next quarter, which is, I'm assuming what you're trying to triangulate on, is it should be similar to the run rate that we had in the fourth quarter. So kind of look at the SG&A for this quarter as an anomaly, and then resetting approximately back to the run rate we had in the fourth quarter of 2011.

And, Frank, I'll take the promotional question. This is Dave. We have not seen any real disruption to the customers of our competitors due to M&A, other than the fact that the sales forces have been consolidated. There's been no network consolidation. There's been no billing consolidation. And, therefore, no real impact.

We think that there is a fairly long window of opportunity for us to continue to garner market share and grow. And I think you will see that in our next quarter's numbers. Clearly, Mega hid things to some extent. But if you just kind of back in the envelope looked at it, we lost in our NetCentric business 11% of our revenues, and our revenues were only down about 6%. So we actually grew that revenue about 5% in the quarter absent that, due to these promotional activities.

And we expect that type of activity to continue going forward. As I mentioned earlier, the backlog is as large as it's ever been. A lot of that is a result of these promotional activities. And we think it is our objective to capture as much share as possible. And we really need to stay aggressive, probably throughout the remainder of this year.

Now, the promotional campaigns change. They're not always the exact same promotions. Part of sales is to make customers get something special that they need at that point in time. So sometimes it's limited to the size [ports], it's the amount of commitment, the amount of term. And we varied our programs a couple of times, learning from the market. And we think that we will continue to be absolutely aggressive on targeting just those specific customers throughout the remainder of this year, that are going to be impacted by these M&A combinations.

That's helpful. And can you give us an idea of the -- so your ARPU came down on new contracts about 7%. Can you give us an idea of what sort of volume [in the] commitment increases you got for that down tick? And then can you give us an idea of what Internet traffic growth would have been in the quarter, excluding Mega, more of on an apples-to-apples basis?

Yes, sure. So let me take the ARPU. A big part of that ARPU decline came from the fact that Mega went away, and they had a large number of ports that were high capacity, full-committed ports. So the rate of ARPU decline reflect the loss of those much more expensive per-port, lower price per megabit, but more expensive per-port connections. You should see a much more moderate rate of ARPU decline going forward.

Now, with regard to traffic, traffic would have grown sequentially on our network. Mega accounted for a little bit over 20% of our traffic. So we would have probably grown traffic in the 5% to 10% range, absent Mega in the quarter. And on a year-over-year basis, it would have been up probably 40%, 45%, on a year-over-year basis, without Mega, as compared to the decline on a sequential basis and the relatively modest year-over-year growth.

Great. Thank you very much.

(Operator Instructions) Tom Seitz with Jefferies.

Thanks for taking the question. Can you give us any -- are you seeing any impact at all with what's going on over in the European economy? And do you anticipate that that will have ultimately any impact? And then just a quick administrative question. Why September 15th, and not a little earlier? Is that time trying to give incoming investors time to get in or -- just the rationale there. Thanks.

Yes, sure. Tom, it's Dave. First of all, I was actually in Europe last week. I met with actually our largest European customer and several customers. I was there for 10 days. And it's pretty interesting. When you walk around on the streets, other than a few protests in Spain, I didn't really notice anything out of the ordinary.

And it's very customer specific. We do not have corporate customers in Europe. Our customers are all NetCentric, and they are either content companies or access networks. Actually, our largest European customers, our I think four largest are all access networks. And they've actually been experiencing growth in traffic volumes. Maybe it's due to the fact that unemployment rates are up and people are at home more using the Internet more. They're all experiencing significant traffic growth and are comfortable in increasing their commitments to us.

So while just by reading the papers it looks terrible, if you walk on the streets, you don't really see it. And more importantly, at least in our product universe, there doesn't appear to be any impact.

Now to your second question around why September 15th. I think there's actually two parts to it. One, you touched on, which is we do really want those shareholders who want to have the ability to get a dividend, to have time to do work and study the company and come onboard, those that maybe don't particularly like companies that issue dividends to have ability to transition away from the company. And we understand there's going to be some transition in the shareholder base. And that was something that the Board debated quite extensively.

I will compliment, we had some shareholder input at our annual meeting that was very helpful in the Board making its decision. We've been asking shareholders to speak up and come, and some did and voice their opinion.

And quite frankly, there's one more thing. We've never issued a dividend before, and we needed to get all the mechanics in place to get that money out there. And having never done it before, we wanted to make sure we had enough time to just put those mechanics in place and not screw it up.

I know companies do it all the time. But in our space, it's not very common and it's something that we really hadn't laid the foundation for. We got the shareholder input, the Board considered it. We had been talking about this for some time, and just decided now was the time to announce dividend, and the Board then just gave us enough time to get all those mechanics in place.

Thanks for the color, Dave.

It appears there are no further questions at this time. Mr. Schaeffer, I'd like to turn the conference back to you for any additional or closing remarks.

Well, thank you all very much. I am glad we're able to get this done in a little less than an hour. I know the last call was extremely long.

Thanks, everyone, for their support. I want to thank the entire Cogent team for giving us great results in the quarter. And we remain extremely encouraged about our prospects going forward, and we look forward to regular mechanism [of] returning cash on a consistent basis to our shareholders.

So with that, thank you all very much.

That concludes today's conference. We thank you for your participation.